Making CfDs work for renewable generators
This is in two parts.
1st - a brief introduction to the Green Power Auction Market.
2nd - gives more detail on the structure and follows on.
We consider this a critical issue for independent generators and
will ask for your support.
Strike price
Income
…And this much
from the CfD
The Government’s objective is that
the generator earns this much for
their power sales….
Time
Reference price
Strike price
Income
Top up for the CfD
Reference price
Reference
Price after PPA
Revenue passed to PPA provider
The generator achieves less than the reference
price for power sales as a result of their PPA, this
will not be taken into account when topping up the
CfD, the generator will not achieve the strike price.
Time
There are three possible solutions …..
1.
2.
3.
Increase the strike price to compensate
Independent generators get squeezed out of the market
Auction the power, in the same way that the NFPA auctions the
power from the NFFO contracts. Each project will have its own
reference price.
Of these solutions …..
1. Increasing the strike price increases cost to consumers,
and might overcompensate vertically integrated
generator/suppliers relative to others.
2. Squeezing independent generators out of the market will
fail to deliver low carbon investment and attract the funds.
3. Auctioning the power, ensures all generators achieve the
strike price and allows suppliers to value the output, along
with any imbalance risks.
This is the end of the brief introduction,
A more
detailed
evaluation
follows.Advisors, MPs etc.
The GPAM proposal
is being
taken around
DECC Officials,
to add your support to this proposal sign up via the link below.
If there are any questions or if you would like
to support this proposal please contact
David Handley , RES
David.handley@res-ltd.com
07957 273 723
If you would like
Green Power Auction Market: Viable Independent Generation under EMR
Falck
Renewables
Pg 6
Defining the Problem
Objectives of the EMR: delivering low carbon electricity at least cost
Delivery is subject to independent generators to securing a viable
route-to-market (a PPA).
Only a limited number of companies offering viable long-term PPAs
The costs charged appear significantly higher than estimates on the
cost of balancing and international comparators.
•
Either the strike price has rise to accommodate this extra cost
•
Or independent generation risks being forced out of the market.
Pg 7
PPAs & Returns
Idealised CfD Structure
-
Strike Price set to give a 10% return
Strike Price
£/MWh
- CFD payment to
- Generator
- Electricity Market
- Revenue to Generator
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Time of Day
Actual CfD Structure
-
Independent generator receives an 8% return
-
£/MWh
-
Strike Price
CFD payment to
Generator
-
PPA Cost
-
Electricity Market
Revenue to Generator
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Time of Day
Pg 8
PPA Margins Appear High Compared to the Costs
Day Ahead Electricity Price
Cost
Source
(% of wholesale price)
10-20%
Current PPAs Terms
1-3%
Nordpool Contracts
3%
Avg NFPA Discount (last auctions)
3-4%
Estimate by Newberry (2011)
Trading, Admin &
Balancing Costs
15 year Balancing
Risk & Margin to
PPA Provider
Electricity Price £/MWh
• The discount charged is set to cover
• The cost of trading
• Administrative expenses
• The cost of balancing
• Long term risk
• Margin to the PPA provider.
PPA
Discount
Revenue to the
Generator
• The additional cost could add £11/MWh
onto the strike price.
Pg 9
Pricing Long Term Balancing Risk
Discount
to Market
Price
+ive
Time (yrs)
Transfer of
value from
consumer
to utility
-ive
PPA Cost
Depends on;
- Actual costs in current market
- Perception of risk
- Expectations of Government policy
- Margin requirements
- Level of competition
Balancing Cost
Depends on;
- Generation Mix
- Interconnection
- Demand Side
Management
- OFGEM review of
balancing
mechanism
Pg 10
Barriers to PPA Competition
• Competition is limited by;
• Finance requirements need for a long term PPA to cover;
1. Short term trading risk;
2. Long-term Balancing risk;
3. Uncertainty whether short term PPAs will renewed.
• Companies ability to offer long-term PPAs is restricted by;
1.
2.
3.
4.
5.
A sufficient credit rating
Willingness to enter the market
Willingness to accept exposure to long term balancing risk
Willingness to accept the risk profile required by financiers
Administrative Cost of providing PPAs to small plant.
• Leads to limited number of companies and lack of competition.
Pg 11
Proposed Solution; Green Power Auction Market
Site’s output is auctioned on a rolling auction for 6 mths of output.
The auction price sets the market reference price, from which the
CfD payment is then made.
Breaks down long-term PPAs into Financeable short-term auctions
Providing;
• Route to market for independent generators.
• Market access for smaller suppliers / new entrants.
• Liquidity into the market
• Lowest costs to the consumer.
• A non-regulatory intervention.
• Implemented through existing market structures.
Pg 12
Reduced Risk Premium Reduces Costs to Consumer
Discount to
Market Price
+ive
Time (yrs)
Balancing Cost
Bid into Auction
Saving to the
consumer
-ive
Pg 13
GPAM : Principles
Structure
Auction
Seller
Purchaser
Default
Existing NFPA structure
Full output for a 6 month (or
longer) period
Provides historical and expected
performance data
Meter registration transferred to
purchaser
Default price is set at zero.
Site-by-site Auctioning
Site specific auction price sets the
market reference price (MRP)
Provides operational data (Scada
links etc)
Takes the balancing risk
GPAM Administration
Data
flows
Electricity
Payments
Generator
GPAM
Auction
Purchaser
MRP
CfD
Payments
CfD
Counterparty
All Suppliers
/ Consumers
Pg 14
GPAM: What it Provides to Generators:
Provides a Route to Market that:
• Delivers for all generators independent of size
• Transfers balancing risk to purchasers (who are best able to handle it)
• Enables 3rd Party debt financing
• Provides an opportunity to compete on a fair basis in future auctions
• Standard contractual terms
CfD Difference Price
CfD
Counterparty
Example CfD Reference Price £70
Site
auction price – period one £40
auction price – period two £35
auction price – period three £80
Auction Price
Generator
GPAM
CfD Difference
Net to Generator
£30
£35
-£10
£40 + £30 = £70
£35 + £35 = £70
£80 - £10 = £70
(in the first operational period, a site can be auctioned on the basis that it starts generating part way
through a period – although typically it will receive less for this part period)
Pg 15
GPAM: What it Provides to Suppliers / Purchasers:
Flexibility
Power available on shorter term basis than PPA market.
Liquidity
Products that are priced on a mid term basis (6mths or
longer) pulling liquidity back from the day-ahead
market.
Convenience
Standardised contracts across many plants.
Diversity
Ability to define a varied portfolio “in one go” from a
diverse mix of types of generation and a broad
geographical range of locations.
Access
Ability to access generation capacity that would
otherwise be tied up in long term contracts with the
large utilities.
Traded
Commodity
(Fungible)
The purchaser can draw a direct comparison between
the auction price and the season ahead price and
trade/arbitrage between them.
Pg 16
GPAM: What it Provides to Government:
A structure that;
• Is attractive to investment funds and new sources of capital.
• Removes the need to estimate long-term balancing risk.
• Increases Transparency.
• Reduces the cost to the consumer.
• Delivers the stated objectives of EMR. In particular;
1.
Providing a stable support mechanism,
2.
Supporting independents and attract new investors into the UK market,
3.
Encouraging investors with a low cost of capital, and
4.
Reducing the cost to the consumer as a result.
Pg 17
Green Power Auction Market: Viable Independent Generation under EMR
The GPAM proposals have been reviewed and their conclusions endorsed by:
Falck Renewables
NFPA have confirmed they are able and willing to fulfil key functions.
Positive discussions are ongoing with a selection of financial institutions, lawyers,
small suppliers, accountants, consultants and other independent generators.
Pg 18
GPAM – Market Implications
Thank you;
Any Questions or if you would like to support
this proposal please contact
David Handley , RES
David.handley@res-ltd.com
07957 273 723
Pg 19
Standardised Contractual Structures
Standardised contractual terms ensure projects are financeable, reduces transaction
costs and reduces barriers to entry for new suppliers / participants
GPAM
•
•
•
•
15 year service agreement
Historical performance
Forecast production
Service standards
Standardised
Contracts
Generator
•
•
•
•
•
• Annual Contract
• Bidding agreement
• Credit and Collateral requirements
• Bid data
Payment Terms
Payment coverage (LECs etc)
Operational Terms
Output data and notifications
Basis for bidding into the
balancing mechanism
Purchaser
Pg 20
Financial Strength
• CfD counter-party is the financial backstop.
• The interface between GPAM and CfD is central to it financial strength.
In particular;
1)
The site’s auction price sets the site’s market reference price
2)
The default auction price is set as zero
3)
The role of GPAM is defined in legislation for the duration of the
CfD contract
4)
The auction is for a limited period, limiting the risk of default
• Uses a structure with a 10+ year operating history
Pg 21
Manage Balancing Risk within a Broader Portfolio
Estimates (Newberry,2012) suggest that balancing individual plant balance
costs between £56-170m/yr more than balancing under a system portfolio.
Allocation of
CfD contracts
Trading Contracts
- Covers Energy Provision &
Balancing exposure
Operational CfD Contracts
Purchases minimise imbalance
exposure across their portfolio
as with existing PPAs
Short Term
Contracts
- Covers
balancing
exposure
Balancing
Mechanism
& System
Operator
Actions
Balancing &
Basis Risk
DELIVERY
New Capacity:
• Covers energy,
capacity and
balancing
ability
3 yrs to day ahead market
Hour before
Delivery
GATE CLOSURE
3-10yrs in advance
Within day
market
Post Event Reconciliation
Time (Moving towards Delivery)
Balancing
service
provision
Purchases bid into
balancing mechanism at
opportunity cost .
Pg 22
Fostering Market Participation
Balancing &
Basis Risk
Balancing
service
provision
Within Day Market - Energy Market
•
Improving portfolio position is managed by the purchaser (as currently the case).
•
Energy forecasting managed by the purchaser (as currently the case).
•
Recognises that low carbon generation will always be incentivised to generate to
access electricity and CfD payment.
•
Obligations on generator to provide reliable data and notifications of outages.
Post Gate Closure - Balancing Market
•
Existing market structures for balancing post gate closure
•
Terms of entering the balancing mechanism are defined in the contract between
the purchaser an the generator.
•
Constraint payments again at the opportunity cost of lost generation as with any
other generator.
•
This provides the national grid a large volume of known cost balancing services
on which it can evaluate investment decisions
Pg 23
Auction Competition
True competition in the auction is essential to ensure accurate price discovery. We
believe that this will arise due to:
• Historical experience: Last two years 4GW auctioned (wind, landfill gas, CHP,
hydro and waste) a half of the winners were ‘big-6’, other half small suppliers.
• Directly comparable to the broader market price, providing a clear differential.
• Avoidance of a competitor picking up “a bargain” incentivising market activity.
• Increased attractiveness to new entrants and small suppliers due to:
• Short duration contracts that reduces the exposure to long term risks
• Low credit requirements (to be balanced against security from default).
• Pre-requisites to enter the auction include a supply licence and being a BSC
signatory are thresholds achieved by most financial participants.
• Market Transparency, full history of auction bids gives transparency to the
market that minimises opportunity to game or distort the market.
In the unlikely event that the auction trades at a significant discount, due to a lack
of participation by large suppliers, then this would suggest broader market
competition issues and the need for regulatory intervention.
Pg 24
Site Not Clearing at Auction
It is extremely unlikely that an individual site won’t clear at auction, on the basis that;
• Historical experience: Never occurred in 10 year operational history of the NFPA.
• If a site is under bid, simple measures can be taken to highlight the opportunity.
The two scenarios which we are aware of where a site fails to clear are:
• Economic Scenario:
• A site may not clear if the income from spilling the electricity grid is
negative over a 6 month period.
• Under current market (and proposed) rules this isn’t considered realistic.
• Market Scenario:
• A site may not clear if the market is suddenly flooded with additional
supply and market capacity is insufficient to absorb it.
• However, there will be visibility of large volumes coming onto the market,
so market capacity can be developed.
• Any impact will be short term as price differential will attract new entrants
Due to the presence of plausible (if extremely unlikely) scenarios that a site will fail
to clear it is important to have the default auction price set to zero to give financiers
confidence to invest.
Pg 25
Quantifying Balancing Costs
• Directly comparable with the
summer and winter ahead prices,
allows
the
quantification
of
balancing costs
• Over the last 8 NFPA auctions
average discount cost of balancing
has been 3% with maximum
discount at 8%.
Identifying the Cost of Balancing
Strike
Price
Winter price (N2EX)
GPAM price
Summer Price
Cost of
GPAM price Balancing
• If the strike price is defined to
exclude the balancing costs, then
GPAM can be use to define
compensation for generators in the
day-ahead market.
• There are many benefits of GPAM.
It could be argued that participation
should be mandatory for CfD
eligible renewable generation.
Winter
Period
Summer
Period
Pg 26
Reduced Risk Premium Reduces Costs to Consumer
Cost of Balancing
By pricing balancing risk on a shorter time period in the auction, lower risk premiums
and caution are passed on to the consumer. In a less competitive PPA market
excessive caution can dominate pricing decisions.
+ive
Time
Balancing Cost
Bid into Auction
Transfer of
value from
consumer
to utility
-ive
PPA Cost
Depends on;
- Actual costs in current market
- Perception of risk
- Expectations of Government policy
- Margin requirements
- Level of competition
Balancing Cost
Depends on;
- Generation Mix
- Interconnection
- Demand Side
Management
- OFGEM review of
balancing
mechanism
Pg 27
Technology Specific Considerations
Onshore Wind
Entered into the site auction on a site by site basis,
• Contracts cover the whole site
• Balancing risk is with purchaser,
• Operational risk with the generator
Offshore Wind
Large offshore sites may need to split to ensure competitive tension
• Contracts cover a share of the site,
• Balancing risk for that share remains with purchaser,
• Operational risk for the whole site remains with the generator
• Separate agreement to govern interaction with balancing mechanism
Thermal
technologies
(eg biomass)
Entered into the site auction on a site by site basis,
• As with onshore wind
• Additional contract to govern fuel exposure and maintenance
New
Technologies
(eg Marine)
Entered into the site auction on a site by site basis,
• As with onshore wind
• Looser operational standards for early stage commercial projects (to be updated
as technology becomes established)
Nuclear
Assumption is that it is unlikely to be entered, otherwise it would be treated in a
manner similar to offshore wind pieces.
Pg 28
Implemented from Outset; can’t wait for Backstop Powers
Time to Implement Backstop Powers
6mth – 1
year
6mths
• Demonstrating that
the market has
failed.
• Consultation
process on solution
to be implement.
Backstop powers will take too long to
implement and a solution needs to
implemented from the outset
Backstop powers scenario
• 1st CfDs expected Q4 2014
: Optimistically, solution in place in 2017
: Realistically, solution in place in 2019
6mths- 1
year
6mths -1
year
• Structuring solution
and legal
contracts.
• Implementing
solution and
building confidence
: Pessimistically, solution in place early
2020s
• PPA market has hit a wall now,
companies can‘t afford a ‘wait-and-see’
approach.
Pg 29